As Goes Darden, So Goes the Economy?

In the 1950s, Charles Wilson the chief executive officer of General Motors (NYSE:GM) at the time is famously attributed with saying “As GM goes, so goes the nation.” The implication was that GM was so big and so important – dare we say essential – that the nation’s economic fortunes depended on having a robust General Motors.

History doesn’t repeat itself, but it frequently rhymes. So when I suggest that the U.S. economy is intertwined with the fortunes of restaurant stocks like Darden Restaurants (NYSE:DRI), I say it with my tongue firmly in my cheek. However, there are parallels.

Despite the growth in manufacturing during the Trump administration, the United States is a service economy. The global pandemic has shown investors how reliant the U.S. economy is on a healthy, thriving service sector. The businesses that have been hit hardest (travel, tourism, and entertainment) will continue to struggle until there is a vaccine for the novel coronavirus.

Restaurants are cousins of a thriving entertainment sector. We are a society that still does dinner and a movie. Restaurants are frequent destinations for travelers. And right now we are a nation that is all dressed up but we have limited places to go.

Darden Made a Difficult Pivot

Given this backdrop, it makes Darden’s fourth quarter earnings report that much more remarkable. The company made an almost impossibly seamless transition from a business model that was virtually 100% dine-in service to a model that was 100% off-premise. Part of that success was the build-out of the company’s digital business.

In the fourth quarter, online ordering at the company’s Olive Garden chain grew by over 300% year-over-year (YOY), making up 58% of its to-go sales. Longhorn Steakhouse, another of the company’s chain stores reported an increase in online ordering of over 400%, making up 49% of to-go sales.

What Will They Do For An Encore?

Investors have been willing to look past earnings and revenue numbers, and rightfully so. Even if Darden beats earnings expectations of 5 cents a share, and the whisper number suggests they may, it will still be a sharp YOY decline. However, it would be encouraging to investors to see the company post positive earnings so soon after the pandemic.

Revenue is another story. Darden is expected to post earnings of $1.53 billion. That would be 20% gain from the prior quarter, but will that be enough to push the stock higher?

Darden stock is up 163% since March. At around $90 per share, it’s trading at levels that it traded at in 2017-2018. But at that time, the company was seeing higher revenue and stronger earnings. It gives the impression that DRI stock may already have priced in all the good news. Analysts seem to agree. Darden receives heavy coverage. Although “buy” ratings outweigh “hold” ratings, the consensus price target of $92.10 gives the stock little room to move higher.

Darden is Strengthening Its Balance Sheet

None of this is to say that Darden is any financial trouble. The company paid off the $750 million they drew down from its credit facility. But the company has suspended its dividend. The company says they will discuss raising its dividend once its free cash flow (FCF) improves. However, with just over $230 million in FCF at the end of 2020, the company will need to see that number double, at least, before it considers reinstating its dividend.

As the virus goes, so goes Darden?

It’s not as simple as U.S. consumers putting on a “stiff upper lip” and frequenting restaurants. The reality in many large American cities is that restaurants are not open. Even in areas where restaurants are open, they are still operating at limited capacity.

And let’s be honest with ourselves. Even if one or more of the biotech companies involved in Operation Warp Speed deliver on the promise of a vaccine, it will be well into 2021 before there is mass inoculation.

In the meantime, there is concern about the double whammy of a resurgence in virus cases along with the outbreak of the seasonal flu. That could have an impact on consumers being willing to venture beyond their phone to do holiday shopping. And that would be a negative for restaurant stocks like Darden in what is normally its strongest quarter.

I’m not as concerned about the impact of a dramatic lockdown. The company has already made the pivot and has proven it can generate revenue from a strictly to-go business. However, the economy is not going to be back to normal when entire segments of the economy are not in operation.

That’s why what Darden management says about their 2021 outlook is more important than the actual numbers.